Monday, August 04, 2008

$9000 Gold on the Way?

29 July 2008

I am adding this entry for playfulness' sake.

In 1974, Jim Sinclair publicly predicted in Barron's that, "Eventually the price of gold will seek a price such that the price of gold in USD times the amount of gold held by the US Treasury will equal the foreign external liabilities, thereby balancing the external balance sheet of the USA."

At the time, Mr. Sinclair predicted that the price of gold would reach $900 by 1980.

Mr. Sinclair's math wasn't that far off, as the price of gold did in fact reach an intraday peak of $887.50 in April 2008. Now that price held only briefly, as Paul Volcker at the Federal Reserve had already begun raising interest rates aggressively to rein in inflation, and by doing so was able to restore confidence in the flagging US dollar.

As noted in Wikipedia: "Paul Volcker, a Democrat[3], was appointed Chairman of the Federal Reserve in August 1979 by President Jimmy Carter and reappointed in 1983 by President Ronald Reagan.[4] Volcker's Fed is widely credited with ending the United States' stagflation crisis of the 1970s by limiting the growth of the money supply, abandoning the previous policy of targeting interest rates. Inflation, which peaked at 13.5% in 1981, was successfully lowered to 3.2% by 1983. [1]"

It is no secret that the Fed has had no chairman as aggressive as Mr. Volcker since that time. In fact, his successors, Alan Greenspan and Ben Bernanke, have been outright promoters of inflation through continued growth in the money supply as a means of fending off a financial recession... or worse.

Unfortunately, the more Mr. Volcker's successors have turned to inflation as a strategy for averting economic hardship, the more they have set the stage for another round of currency devaluation with corresponding surges in the price of gold.

Therefore, I though it would be interesting to repeat Mr. Sinclair's calculation in our time, using figures obtained through Contrary Investors' Cafe.

The U.S. Department of the Treasury calculates the net Federal debt held by foreign and international investors on a quarterly basis. The latest (March 31, 2008) report indicates that the net foreign debt position of the US government is presently sitting at $2.4386 trillion.

The US government at last report held approximately 8133.5 tons of gold, which at 32,000 ounces per ton represents a total of 262 million ounces of gold.

So, let’s now divide that $2.4386 trillion figure by 262 million ounces of gold.

What do we get?

An imputed peak gold price of $9307.

Now, here’s something even more interesting. Net US foreign obligations increased by roughly 10% ($242 billion; 0.098%) from March 31, 2007 through March 31, 2008. If that trend continues, and if the US government continues selling its gold holdings, this thought experiment would surely very quickly take us to a gold price over $10,000 per ounce.

I have so far been unable to find exact figures reporting the rate at which the US government is selling its gold holdings. Coinlink reports that none of the world’s central banks disclose the amounts of their gold sales. Therefore, Gold Fields International (now GFMS) publishes an annual estimate of central bank gold sales based on second hand or third party information. An overview of these publications, now in their 40th year and available for purchase, is linked here.

I have found a May 2007 overview of central bank gold sales here. All indications are that gold selling is proceeding apace, as several central banks have virtually exhausted their gold supplies, including Canada and the United Kingdom, as I have reported previously. I have learned that as of March 2007, central bank gold holdings had reached their lowest levels since 1948, at which time gold holdings had been depleted by years of world war.

Again, today's gold price estimate is merely a thought experiment. However, it is certainly interesting to contemplate where the price of gold might go should citizens around the world continue to lose faith in the ability of their governments to manage public finances wisely.

Should the gold price revert to historic norms as a guarantor of currency values - retaking its multi-millennial status as the true global reserve currency, if you will - then these estimates could in such a case prove to be very realistic indeed!

The question at this point would be how seriously you take the prospect of a broad loss of confidence in the currencies of the global powers. My present guess is that the odds of this are less than 50%, but that the possibility of a US and then a global currency collapse cannot be ruled out.

My advice - why take the chance? You know that no matter what happens in an uncertain world, gold will always retain its value. And if uncertainty increases, the value of gold is likely to increase as well!

Oh, and another interesting fact for you. The US dollar remains the world's first choice as a reserve currency. According to Wikipedia, while the Euro has increased from constituting 17.9% of global reserves in 1999 to 26.5% of reserves in 2007, the US dollar still constitutes 63.3% of all foreign currency reserves around the world, down from a peak of 70.9% in 1999.

If the US dollar were to remain unpopular, or to become abhorrent to its holders, it obviously could have further to fall... much further!

Bear in mind also that not all nations are selling gold. Some are buying, including Russia (in particular), China (registering large increases), Japan (direction not clear), the Philippines, India, maybe Venezuela (the Chavez government is secretive, and is inflating its currency rapidly), and reportedly a still small number of the Middle Eastern states at this time (only Indonesia and Libya as of 2005). Smaller buyers include Argentina (after a bout of exhaustive sales while pegging the currency to the faulty US dollar), South Africa, Bulgaria, Poland, Romania, Kazakhstan, Belarus, Tajikistan, Suriname and Ukraine.

The best source of publicly-available information I have found so far is a May 16, 2005 summary of central bank gold reserves over time, from 1980-2005, published by GATA (click here). GATA notes that the central banks sold 435 tones of gold per year from 1990-2005, depleting their reserves by 4500-6500 tons during that period (the amount is disputed). Exceeding 35,000 tons in 1990, world central bank gold holdings had fallen to 29,813 tons in 2007. It is estimated that a total of 145,000 tons of gold has been mined so far in human history.

Give full attention to these facts when you consider which currencies are likely to hold up best if a currency crisis does develop. Bear in mind too that in the event of a far-reaching currency collapse, the nominal value of gold would have little meaning in any case, because the currencies in which it is denominated would no longer be perceived as genuine stores of value. That is, a gold price much higher than $10,000 per ounce would indicate the exhaustion of the value of the currency in which it is denominated (in the case of our discussion, the US dollar).


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